Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Keli Sensing Technology (Ningbo) Co.,Ltd. (SHSE:603662) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Keli Sensing Technology (Ningbo)Ltd's Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Keli Sensing Technology (Ningbo)Ltd had debt of CN¥635.2m, up from CN¥495.7m in one year. However, it does have CN¥1.33b in cash offsetting this, leading to net cash of CN¥693.4m.
How Strong Is Keli Sensing Technology (Ningbo)Ltd's Balance Sheet?
The latest balance sheet data shows that Keli Sensing Technology (Ningbo)Ltd had liabilities of CN¥1.15b due within a year, and liabilities of CN¥29.0m falling due after that. On the other hand, it had cash of CN¥1.33b and CN¥543.6m worth of receivables due within a year. So it can boast CN¥693.1m more liquid assets than total liabilities.
This surplus suggests that Keli Sensing Technology (Ningbo)Ltd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Keli Sensing Technology (Ningbo)Ltd boasts net cash, so it's fair to say it does not have a heavy debt load!
While Keli Sensing Technology (Ningbo)Ltd doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Keli Sensing Technology (Ningbo)Ltd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Keli Sensing Technology (Ningbo)Ltd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Keli Sensing Technology (Ningbo)Ltd created free cash flow amounting to 8.3% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Keli Sensing Technology (Ningbo)Ltd has net cash of CN¥693.4m, as well as more liquid assets than liabilities. So we don't have any problem with Keli Sensing Technology (Ningbo)Ltd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Keli Sensing Technology (Ningbo)Ltd you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.